Wednesday, December 05, 2012

Is a bailout a tax?

Mulligan's thesis is that because poverty rates didn't rise in the Great Recession (once you factor in government transfers), poor people now face an effective 100% marginal tax rate on their income; make one dollar more, if you're a poor person, and your government benefits go down $1. Here's Mulligan:

When measured to include taxes and government benefits, poverty did not rise between 2007 and 2011, and that shows why government policy is seriously off track...

[W]hen someone loses $10,000 by not working, he should get some help from the government or from others in the forms of reduced taxes and enhanced benefits but still should bear a portion of that loss himself...

If people with declining incomes found them entirely replaced by government help, that amounts to 100 percent taxation (providing more benefits as income falls is sometimes called “implicit taxation”)...

Erasing incentives is not the way to a civilized society but rather to an impoverished one.

Casey Mulligan's general point - that the expiration of government benefits is a form of implicit taxation - is a good one. But I don't agree with his conclusion about the Great Recession. Just because poverty rates didn't rise doesn't mean that the government imposed a 100% implicit tax rate.

Suppose that the government gave out cash to poor people in order to keep the poverty rate at or below 15%. Would that make it impossible to become poor? No. Because you'd still have a chance of becoming one of the 15%. If you work less than the poor guy next door, it's possible that you'll fall into the 15% and he'll rise out of it. The aggregate poverty rate will stay the same, but now you'll be poor. In other words, there is still an individual incentive for people to work, even if the aggregate poverty level is held fixed.

Or take another, even simpler example. Suppose the poverty level is $10,000 per year. Suppose the government decided to hand every citizen exactly $10,000 per year (raised with an income tax on people making above the median income). The poverty rate would then be permanently fixed (at 0%), and yet for everyone in the lower part of the income distribution, the implicit marginal income tax rate would be unchanged from whatever it was before the policy.

(Now, if poor people could somehow coordinate - if they could get together and say "Hey guys, let's all not work, and then the government will give us all bigger checks!" - then the government policy would indeed produce a 100% tax rate. But poor people can't coordinate like that in real life. And if somehow they did, the government could probably see them doing it, and change the policy to avoid getting ripped off.)

Note that in my example, the antipoverty programs are permanent. They are not temporary recession-fighting measures. My argument does not depend on the temporary nature of the incentive structure.

But in real life, the programs that Mulligan is talking about are temporary, and that actually makes my argument even stronger. Programs to keep the poverty rate constant during a recession are like bank bailouts - they are only likely to be used in a time of systemic crisis. If the overall economy is doing well, the government will be much more likely to allow the poverty rate to grow (this is basically what happened in the Bush years). And poor people know this. Since incentives depend on the future as well as the present, this means that we can't just look at what happened during the Great Recession in order to make conclusions about incentives.

In other words, I think Casey Mulligan makes two mistakes here: 1) He confuses individual incentives with aggregate outcomes, and 2) He assumes that poor people are not forward-looking.

Now, remember, Mulligan's more general point is still correct: The phase-out of antipoverty programs as income rises acts as an implicit marginal tax. But there is little we can deduce about the strength of this incentive just by looking at aggregate incomes during the Great Recession.

40 comments:

Let's talk some more about the example in your "Suppose that the government gave out cash to poor people..." paragraph. Are you saying that some people in this recession did fall into poverty, but that an equal amount escaped poverty so the rate is unchanged?

If you think about it, you'll realize that this almost certainly did happen.

If the # of poor people before and after the recession was exactly the same (as Mulligan asserts), then the only way that nobody escaped poverty during the recession would be for the set of poor people to remain identical. And pure chance almost surely rules that out.

Sure, every year random chance will shift some in and some out. But during 2007-2011 with people receiving large income shocks an exceptionally large number in excess of the normal random amount to be shifting into poverty. To offset this exactly you also need an exceptionally large number of people shifting out of poverty. Why would this happen during a recession?

It happened because of government transfers. Some poor people's pre-tax incomes didn't fall very much during the recession. The government handed out checks to all poor people. So the people who's pre-tax income didn't fall much during the recession rose above the poverty line in terms of after-tax income.

I am not familiar with the poverty statistics in Mulligans's blog post, but I have a paper with Fabrizio Perri on a very similar topic that addresses the last few questions about churn. You can find one version of it here: http://www.minneapolisfed.org/publications_papers/pub_display.cfm?id=4819

We find that while earnings inequality between middle- and low-earners (as measured by the 50-20 ratio from the CPS) skyrocketed during the recession, the same measure for disposable income was completely unchanged. And we show that this is, as Mulligan asserts, due mostly to government taxes and transfers.

However, when you look at the PSID you do see a lot of churning at the bottom of the distribution, and households that enter the bototm 20% in earnings also see a large (but smaller) drop in disposable income. So people that enter the bottom of the earnings distribution do in fact do pretty badly, and government transfers don't come close to completely mitigating their earnings drops.

Of course, this isn't perfect since the PSID data we used ended in 2008 so we only got the first few months of the recession, but I did a similar thing with SIPP data through 2011 and had very similar findings that we haven't put into a paper yet.

But the bottom line is that the composition of low-earning households is not at all constant, and households that become low-earners see large drops in disposable income in addition to earnings.

Another missing piece is how antipoverty programs work. Under the deal between Clinton and the Newt Congress, people were required to move from welfare to work. But rather than simply cutting off all benefits to the working poor, Clinton insisted on Make Work Pay. EITC, child care subsidy, &c, &c made the movement from welfare to work pay much more than welfare, by some estimates 7 times more. This is a HUGE incentive to work. Under Clinton, there was full employment so the combination of jobs plus subsidies lifted millions out of poverty and produced the lowest poverty rate in the US. Certainly extending UI make unemployment a better deal than otherwise, but we are far from full employment. If we were at full employment, there would be no need to extend UI.

How did Mulligan get so clueless about the income and incentives for the working poor? Mulligan needs to look at real income data comparing net income of those who work to net income of those who welfare. The US has huge disincentives to be unemployed.

Even if the anti poverty program were perminent and kept you just above the poverty line surely returning to work would at some point yield higher wages than the government program? At the very least if we're taking a discounted rational expectation of future income then putting a floor on your income always increases the sum, in effect you only have to consider future states of the world in which you get promoted and are paid more.

If not, if the only work you could do was and would alwasy be paid at the poverty level, then surely that's a bigger problem in incetive terms than the marginal tax rate at this one moment in time?

Mulligan has long been completely unable to imagine what life is like for people living near the poverty line. Both the family living at 90% of the poverty line and the family living at 120% of the poverty line have HUGE incentives to find more or better-paying work. Life on these incomes is very hard, you constantly worry yourself sick about the impact of a income or expense shock.

I have this fantasy that Mulligan should spend 6 months living on the average unemployment benefit in Illinois. I wonder if he would then be so certain that unemployment benefits are a disincentive to work. As he watched his house being foreclosed.

That's the rub, isn't it? All of these people say "Look how great it is being poor and handed all these benefits. There's no incentive to work!" But they themselves keep working rather than receive the benefits. What explains the disconnect?

Well, it's hard to prove, but I think it has to do with Mulligan, etc., implicitly (or explicitly!) thinking, "Well, but I'm better than THOSE people. I have a moral compass and it would degrade my dignity to receive handouts, so I am motivated. But THEY are shiftless and lazy. I mean, after all, they're poor."

Mulligan has explicitly said it is NOT good being poor, and it IS GOOD to help poor people (by, say, giving them money). But if you are poor and your marginal tax rate is 100% (the disputed premise hear), you don't have an incentive to earn a marginal dollar (I'm ignoring the issue of in-kind transfers worth less to the recipient than their nominal cost), because it won't improve your situation at all but instead just result in loss of benefits. The problem for Casey is not lack of empathy but a misunderstanding of individual vs aggregate outcomes.

"But they themselves keep working rather than receive the benefits. What explains the disconnect?"A major part of Mulligan's argument is that different people face different marginal tax rates and different incentives. So when he sees employment shifting differently across different groups (young vs old, skilled vs unskilled, married vs unmarried etc) he tries to use that to argue that the cause is not a broad drop in aggregate demand but other factors which differ among those groups. The argument against that should be that there is a "norm of reaction" issue where certain people might, say, become Zero Marginal Product workers after an AD shock while others still produce positive marginal product.

"(Now, if poor people could somehow coordinate - if they could get together and say "Hey guys, let's all not work, and then the government will give us all bigger checks!" - then the government policy would indeed produce a 100% tax rate. But poor people can't coordinate like that in real life. And if somehow they did, the government could probably see them doing it, and change the policy to avoid getting ripped off.)"

This by the way will only apply to conditional benefits. If everybody was handed a $10,000 check and then could earn on top of that, then co-ordinating to stop working would only make them all poorer. It's pretty difficult to see why they would all WANT to do that.

I don't get it. If the government made a lump sum payment to all *poor* people, that necessarily involves a means test for each individual poor person. I don't see how any means tested payment, to the extent that it is expected, is not an income disincentive.

So, the key here is to think on the margin. Imagine you make $8,000 before tax, the poverty line is $10,000, and the median income is $50,000. Because you are below the median, the government hands you a check for $10,000, so that your after-tax income is $18,000.

Now, suppose you were to go out and work and earn one extra dollar, raising your pretax income to $8,001. Your after-tax income goes up to $18,001. In other words, your added work effort has not been taxed at all. See?

Now, in this simple example, someone who makes $49,999 - in other words, someone who is just below the cutoff for the $10,000 check - faces a huge disincentive to work. Earning an extra dollar, for that person, means losing $10,000 in benefits. So an implicit labor tax exists somewhere in the economy, due to the means testing. It just doesn't exist anywhere near the poverty line. So looking only at what happens at the poverty line doesn't tell us anything about the effect of the implicit labor tax.

Noah,what a pleasure to have a blog where the author participates in the ongoing conversation. (I also like that you address Casey's ideas. I'd much prefer not having to wade through the dismissive comments about him, even though I understand why people feel that way)

Their is an underlying conceit that rich people are rich due to their hard work, and it's corollary conceit, that people who need assistance are lazy and indolent.

Gussy up the ideas in econo speak and you can get away with calling people lazy. I simply don't think that increases in unemployment reflect increases in laziness, and I don't think decreases in unemployment reflect decreases in incentives to be lazy.

It's apparent from your comments that few of your commenters actually bothered to read Mulligan's original article despite the link you provided.

Also, your last two posts have had about the same form. In the case of both Mulligan and Beckworth, you are basically saying they make the mistake of thinking fact A implies effect B when you think there are other possible explanations. As a matter of logic, I think you are correct both times. But, as a matter of your opinion, what do you really think? It's not clear to me. I think that both exaggerated the relationship (Mulligan more than Beckworth), but that both are partially correct.

Also, even some economists who should know better throw around observations based on the poverty line without remembering what a arbitrary measure it is (a single nationwide threshold based on regional cost of living surveys). In this recession, there have been a ton of regional effects because the slowing was far from uniform. There also are likely tons of boundary effects (i.e. 1 person falling by a lot to get below the poverty line, 2 people gaining slightly to come out over it).

Also, your last two posts have had about the same form. In the case of both Mulligan and Beckworth, you are basically saying they make the mistake of thinking fact A implies effect B when you think there are other possible explanations.

Similar, yes. But a little bit different. Beckworth's problem was interpreting a reduced-form relationship as structural. That's not valid, but still, reduced-form relationships may point us in the direction of structural relationships.

Mulligan, in contrast, just completely fails to understand the nature of individual incentives. It is a remarkable failure for a professional economist. And note that the implicit marginal tax rate that he discusses is actually observable, so he doesn't even need to (wrongly) infer it from aggregate poverty rates.

But, as a matter of your opinion, what do you really think? It's not clear to me. I think that both exaggerated the relationship (Mulligan more than Beckworth), but that both are partially correct.

I'm not sure, and I'd rather live with uncertainty than portray myself as knowing more than I do. That said, my guess is that the fiscal multiplier is highly dependent on the type of stimulus, with government investment having a high multiplier (in countries where there is an infrastructure deficit, like the US), government consumption having a lower multiplier, and tax credits having a multiplier that is essentially zero.

As for Mulligan's thesis, I highly doubt that recession-fighting programs have made any person substantially less willing to work in order to escape or avoid poverty.

Also, even some economists who should know better throw around observations based on the poverty line without remembering what a arbitrary measure it is (a single nationwide threshold based on regional cost of living surveys).

Thanks for that response. Mulligan is really really sloppy in his argument, which pisses me off as someone with a Chicago economics degree. However, Bernstein's logic is really not better.

I am going to channel Mulligan for a moment and create a thesis that supports his point. One way to stop the poverty rate from rising in a recession is to raise the minimum wage and this was done during this recession. I think most economists agree that puts at least a few people out of work, ensuring that they fall below or stay below the poverty line. However, those who remain employeed have a very good chance of creeping over the line. Statistically, this looks positive from the % poor perspective. But its not necessarily a sign of sign of a "far more civilized society". That would really depend on the proportions of newly unemployeed to the somewhat more well off and the social utility of various outcomes. Again, the poverty line is not the way to measure this since it implies an entirely binary utility function.

I mean, if "Mulligan's point" is just that anti-poverty policies in general end up hurting some poor people, then sure, it's possible to find theoretical Econ 101 type examples of that. How big a factor they are, of course, depends on careful empirics.

Noah, another point is that Mulligan assumes that people's choice is continuous. For example, whether to work a few extra hours or not. Maybe that would be the case for people working part-time. But as Hansen has pointed out, there are a lot of discontinuities in labor choice. If a person had to choose between earning $10,000 in government support by not working and $16,000 by getting a full-time job it is not clear at all that they would choose to not work. It all depends on the value they place on having the extra $6,000 dollars.

Yup. I hadn't noticed that your threshold was far above the poverty level.

What kinds of income support programs kick in *not* in response to a change in your personal situation? Were there a lot of poor people who were previously doing nothing who suddenly started getting government checks as a result of the recession? Or was it maybe a change in the minimum wage?

I didn't read Mulligan's post, and I don't care to if what you say is correct. If he truly doesn't believe poverty rates went up, ever, during the Great Recession, well, a claim like that speaks for itself.

I've made this point before about Casey Mulligan - he is almost always "not even wrong".

Always the argument he makes has general validity in some cases. But almost always not in the specific cases to which he applies it. If he were to say for instance, that the micro-economic design of public assistance in the US could be improved considerably - would people think he was a fool (as they mostly do)?

Most of the government assistance involved is of an insecure and transitory nature, and so even if in an individual case it offsets lost wages 1 to 1, that doesn't mean the incentive to look for higher wages disappears. If my boss cuts my weekly salary by $50, and then hands me $50 as a "personal assistance" bonus that I will get for a finite period of weeks, but which might be shrunk or not extended at all after that. I still have plenty of incentive to start looking for a better job.

Looking at this issue from the public direction rather than the individual direction, if we end up in a situation where we are paying people a secure income not to work, perhaps it is time we institute a public Job Guarantee program and begin paying people to work.

What a coincidence. Here's what I just posted in a forum thread that's dedicated to a blog entry of yours...

1. gavinfielder created this thread to share Dan Kervick's article...Paying for Lunch – MMT Style2. Dan Kervick's article attempts to address the widely held economic belief that there's no such thing as a free lunch.3. If you've read the Wikipedia entry that I linked to...then you'd know that "TANSTAAFL demonstrates opportunity cost"4. Opportunity cost ensures "that scarce resources are used efficiently" 5. Pragmatarianism is based on the opportunity cost concept6. Therefore, allowing taxpayers to spend their taxes in the public sector would ensure that scarce resources are used efficiently

It would be super cool if you could join that forum and give your supporters a hand with my critique.